When it comes to planning for your retirement, we all know there are thousands of online resources and books that claim to teach you how to DIY (do-it-yourself). So is it really possible and does it work?
DIY retirement planning requires advanced knowledge and understanding in the following areas: investments, tax planning, insurance and estate planning. Not to mention, it would also be beneficial to have substantial knowledge in Social Security claiming strategies.
While there is plenty of information on each one of these topics, it is the interaction between these different areas that could make it difficult to have an effective DIY retirement plan.
One thing that is often overlooked is that circumstances may change as you head into retirement, including your feelings toward risk. In order to have a good do-it-yourself retirement plan, you need to be able to identify exactly what your money needs to do for you. An effective plan should include how much money (net of taxes) you need to have deposited to your checking account each and every month to have the lifestyle you want.
To determine if you are on track, you need to understand how each and every retirement account will be taxed upon withdrawal. Taxes in retirement are totally different than taxes during your working years. When you’re working you likely have W-2 income and taxes are being withheld from your paycheck, so it’s rather easy to understand what your net spendable money is. When you retire, however, this becomes far more complex.
When it comes to the taxation of your Social Security, it used to be easy – benefits were tax free. In April of 1983, President Reagan signed into law the taxation of Social Security that stated that up to 50% of Social Security benefits could be considered taxable income, as long as the recipient’s total income was over certain limits. In 1993, another income limit was added that increased the number of benefits subject to taxation. As of today, there are some retirees collecting all of their benefits tax-free while others are required to pay taxes on their Social Security. In order to determine how much (if any) is taxable, the IRS uses a provisional income calculation by adding the gross income, tax-free interest, and 50% of the Social Security benefits.
Dividends and capital gains are also treated differently when it comes to taxation. Depending upon your tax bracket, long-term capital gains and qualified dividends can be tax-free. However, once you breach the 25% tax bracket these once tax-free assets will become taxable. This could trigger additional tax on your Social Security and cause even higher taxes on any distributions coming out of your retirement accounts.
Understanding how all of the different accounts that you have and how they will be taxed will ultimately determine how much taxes you pay in retirement. Most people unknowingly pay far more than what they need to in retirement because they do not understand distribution when it comes to taxation.
If you’re a DIY’er, make sure that you’ve considered all of the above. If after reading this you feel that it may be beneficial to speak with a qualified financial advisor to make sure you’re on the right track, fill out the form below.
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